Monday, September 15, 2014

How Economists Got it Wrong - Krugman

Last week I participated in a conference organized by Rethinking
Economics, a student-run group hoping to promote, you guessed it, a
rethinking of economics. And Mammon knows that economics needs rethinking in
the wake of a disastrous crisis, a crisis that was neither predicted nor
prevented.

It seems to me, however, that it’s important to realize
that the enormous intellectual failure of recent years took place at several
levels. Clearly, economics as a discipline went badly astray in the years —
actually decades — leading up to the crisis. But the failings of economics were
greatly aggravated by the sins of economists, who far too often let
partisanship or personal self-aggrandizement trump their professionalism. Last
but not least, economic policy makers systematically chose to hear only what
they wanted to hear. And it is this multilevel failure — not the inadequacy of
economics alone — that accounts for the terrible performance of Western
economies since 2008.

In what sense did economics go astray? Hardly anyone
predicted the 2008 crisis, but that in itself is arguably excusable in a
complicated world. More damning was the widespread conviction among economists
that such a crisis couldn’t happen. Underlying this complacency
was the dominance of an idealized vision of capitalism, in which individuals
are always rational and markets always function perfectly.

Now, idealized models have a useful role to play in
economics (and indeed in any discipline), as ways to clarify your thinking. But
starting in the 1980s it became harder and harder to publish anything
questioning these idealized models in major journals. Economists trying to take
account of imperfect reality faced what Harvard’s Kenneth Rogoff, hardly a
radical figure (and someone I’ve sparred with) once called “new neoclassical repression.” And it should go
without saying that assuming away irrationality and market failure meant
assuming away the very possibility of the kind of catastrophe that overtook the
developed world six years ago.

Still, many applied economists retained a more realistic
vision of the world, and textbook macroeconomics, while it didn’t predict the
crisis, did a pretty good job of predicting how things would play out in the
aftermath. Low interest rates in the face of big budget deficits, low inflation
in the face of a rapidly growing money supply, and sharp economic contraction
in countries imposing fiscal austerity came as surprises to the talking heads
on TV, but they were just what the basic models predicted under the conditions
that prevailed postcrisis.

But while economic models didn’t perform all that badly
after the crisis, all too many influential economists did — refusing to
acknowledge error, letting naked partisanship trump analysis, or both. “Hey, I
claimed that another depression wasn’t possible, but I wasn’t wrong, it’s all
because businesses are reacting to the future failure of Obamacare.”

You might say that this is just human nature, and it’s
true that while the most shocking intellectual malfeasance has come from
conservative economists, some economists on the left have also seemed more
interested in defending their turf and sniping at professional rivals than in
getting it right. Still, this bad behavior has come as a shock, especially to
those who thought we were having a real conversation.

But would it have mattered if economists had behaved
better? Or would people in power have done the same thing regardless?

SEE
ALL COMMENTS

If you imagine that policy makers have spent the past
five or six years in thrall to economic orthodoxy, you’ve been misled. On the
contrary, key decision makers have been highly receptive to innovative,
unorthodox economic ideas — ideas that also happen to be wrong but which
offered excuses to do what these decision makers wanted to do anyway.

The great majority of policy-oriented economists
believe that increasing government spending in a depressed economy creates
jobs, and that slashing it destroys jobs — but European leaders and U.S.
Republicans decided to believe the handful of economists asserting the opposite.
Neither theory nor history justifies panic over current levels of government
debt, but politicians decided to panic anyway, citing unvetted (and, it turned out, flawed) research as
justification.

I’m not saying either that economics is in good shape or
that its flaws don’t matter. It isn’t, they do, and I’m all for rethinking and
reforming a field.

The big problem with economic policy is not, however,
that conventional economics doesn’t tell us what to do. In fact, the world
would be in much better shape than it is if real-world policy had reflected the
lessons of Econ 101. If we’ve made a hash of things — and we have — the fault
lies not in our textbooks, but in ourselves.